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This article first appeared in The Edge Financial Daily, on November 16, 2015.

 

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Insider Asia’s Stock Of The Day: Powering up on long-term export growth

Following our recent focus on frozen food and confectionary companies within the food & beverage (F&B) sector, today we look at the instant coffee segment of the fast moving consumer goods (FMCG) subsector. Instant coffee manufacturers boast relatively defensive qualities as spending on the item is largely non-discretionary for most households.

Moreover, current subdued commodity prices will continue to bode well for the players. Their main raw materials are coffee, sugar and creamer. Over the past one year, coffee has declined 42% to US$116.8 per pound while sugar has dropped 19% to US$14.7 per pound.

Having said that, the weaker ringgit has raised the import costs as raw materials are generally imported, although the impact is mitigated by lower commodity prices. Those that have significant exports can mitigate this impact, enjoy stronger USD-denominated export revenues and provide a buffer for slowing domestic sales.

Key players operating in this segment include Nestle Malaysia Bhd, Power Root Bhd and Oldtown Bhd. Most of them have strong cash-rich balance sheets and pay decent dividends, with 3-4% yield (see table 1).

Over the years, they have developed their own brands with different target markets. Like other F&B companies, we tend to favour companies with established brands and growing export markets:

 

1.    Industry leader Nestle commands the largest market share in the country with its leading brand Nescafé. Besides instant coffee, it also sells a variety of food and beverage products under well-recognised brands such as Milo, Maggi, Nespray and Kit Kat.

In 2014, Nestle derived most (79%) of its revenue locally with the remaining 21% coming from export sales (see chart 1). Although the weaker ringgit has raised its import costs, the effect was offset by the fall in commodity prices, especially for milk powder and coffee beans. For 3Q2015, net profit jumped 19% y-o-y, outsizing a 5% growth in sales. Trading close to its 3-year average P/E of 29.1 times though, we think Nestle is probably fully valued at the moment.


2.    Homegrown Oldtown operates in 2 segments: café chain operations and beverage manufacturing, which accounted for 40% and 60% of operating profit, respectively, in FYMar2015. This enables efficient cross-selling and brand building. As the market leader in the white coffee market, Oldtown is among the top three coffee mix players in Malaysia, Singapore and Hong Kong.

However, the company is highly exposed to discretionary consumer spending although its export business is growing. Indeed, Oldtown’s net profit has been on a downtrend for the past 2 years due to the café chain segment, which we are cautious on due to the weak outlook for consumer spending amid the goods and services tax (GST) and weakening economy. As such, we are not keen on the stock, although its valuations are not excessive at a trailing P/E of 14.1 times.

 
3.    This leaves us with our preferred coffee play Power Root, which is a pure beverage manufacturer. As one of the country’s top three instant coffee maker, it is best known for its Tongkat Ali-flavoured Alicafe and Ah Huat white coffee brands.

Since a slump in 2009, the company has been actively growing its brands and diversifying its earnings base by venturing into the Middle East. Export sales grew rapidly, accounting for 38% of sales in FYMar2015 from just 5.5% when it was listed in 2007.

Power Root plans to grow its market share in the Middle East where instant coffee penetration is still low. The company targets export sales to contribute 50% of total revenue in the next few years.

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Power Root Bhd

SHARES of Power Root (Fundamental: 2.4/3, Valuation: 2.1/3) have risen 33% to RM2.75 since we first recommended it back in July. We continue to like the stock for its resilient FMCG business, growing export sales and decent yield of 3.7%.

Stewarded by entrepreneurial and hands-on management, sales doubled to RM306.9 million (see chart 2) while net profit surged almost four-fold to RM38.8 million for FYFeb2010–FY2014. During this 5-year period, dividends also increased from 4 sen to 9 sen.  

Power Root ended its 13-month FYMar2015 with a strong set of results for 4QFY2015, boosted by the timely completion of a property development project. It declared a special dividend of 2.5 sen, bringing up total dividends for FY2015 to 10 sen.

However, on an annualised 12-month basis, core net profit declined 27% to RM28.5 million while sales growth was flattish. Core net margin contracted by 3.2 percentage points, mainly due to a RM19.1 million increase in marketing expenses to RM73.0 million (which amounted to 22% of revenue).

Although domestic demand may continue to remain weak, we expect margins to improve this year.  Marketing expenses should normalise to account for 15-20% of sales in FY2016 as it scales down its aggressive marketing campaigns. It was also granted tax incentive by MIDA and may enjoy an income tax exemption from FY2016 onwards.

For 1QFY2016, it posted a net profit of RM14.7 million, up 57% from RM9.3 million in 1QFY2015, thanks to post-GST restocking activities by distributors, higher export sales and forex gains. Moving forward, it is constructing a new plant in the UAE, which will boost production capacity by more than 50% by 2017.   

For a growing F&B company with strong brand equity, Power Root trades at fairly reasonable valuations. The stock trades at a trailing P/E of 17.0 times vis-à-vis peer Oldtown’s 14.1 times and industry leader Nestle’s 29.0 times.

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